Again, a disclaimer before reading further, this is the just first part of my notes on the top twenty securities by market capitalisation. Please also note, this does not necessarily mean that we currently hold any of them, especially given our domestic equities mandates are broadly ASX ex20. ​

Context 

Perhaps one of the most important characteristics of successful investing (in my view) is the ability to accept when you may have gotten something wrong, figure out why and learn. When it comes to the Australian banks, it is one area that I got wrong. For many of you that may be familiar with my previous writings, you may know that I have consistently had a broadly bearish view on the sector given the monetary policy and regulatory environment not only post-covid but pre-covid with the conclusion of the Royal Commission. Much of my previous thesis was predicated upon declining NIM’s (Net Interest Margins) as well as, the (in)ability of the RBA to maintain a positive cash rate.

On both counts the markets have defied expectations. Not only did Lowe maintain the stance of not taking rates negative bound or even 0 as his counterparts globally were so willing to do, the banks have been adept in ascertaining and taking advantage of lower funding costs. This, combined with the Term Funding Facility, has meant that firstly the sector was provided a tailwind of 5bps on the deposit front (which should move further should term deposit rates move downward toward the headline cash rate of 0.1%) and the TFF which added another 4bps.

All this combined with a more than buoyant property market has seen stellar growth in the loan books and has stabilized the Big 4 respective PPOP (pre-provisioning operating profit). On top of this, kudos to the management teams for ensuring that over 80% of the total mortgage book remains variable (de-risking the portfolio). On top of this, the better than expected pickup in economic activity in the broader market, furthered in no small part by the fiscal largesse, has ensured that much of the mortgage deferrals, which were the major issue during much of last year, have been improving considerably. And thankfully, the public with its rather short memory has put the findings of the Royal Commission behind it (thankfully for shareholders that is).

Despite management commentary being on the conservative side and provisioning sitting 1.8bn above its scenario modelling, CBA has continued to deliver. Unchanged PPOP, lower bad debts and increased payout ratio (a boon for the dividend starved investor) were the main highlights. Numbers wise, 1H21 cash earnings of $3.886bn, net interest income came in at $9.371bn compared to $9.26bn in the previous half. More importantly costs have been kept in check with the biggest highlight being the strong capital position, standing at 12.6% (this has beat my expectations slightly given that even with the sale of non-core assets I expected 12.5%).

Nevertheless, while the results have surprised me on the upside, the statutory NPAT of $4.877bn AUD (a decline of 20.8%) does show the toll that Covid has placed on the business.

Red Flags & Risks: NIMs continued to fall from 2.04% to 2.01% (above the expectations of 1.8%-2.0% that I gave last year). This will, in my view, stabilise. However, the competitive nature of the mortgage market in this nation will offer considerable headwinds going forward with the potential for downward mortgage repricing. The current valuation also ignores the impact of lower rates and is already focusing on dividend yield.

My Expectations: Cash NPAT will remain broadly flat but the payout ratio should increase in order to catch up. The firm’s recent foray into BNPL, though still in its infancy, shows that management is looking to keep abreast of changes in the economy. The offering of lower charging (1.4% vs. APT’s 3.8%) is unlikely to be enough to eat away at APT’s market share substantially though. What it is likely to do however is further increase customer retention and increase the profitability per customer by offering more holistic services. Its ability to ascertain better credit data gives it a unique advantage over its competitors (though if NAB’s Klarna is anything to go by, this will not be substantive).

Dividend Yield: 4.09% (assuming share price at $88 AUD and a 68% payout ratio – in absolute terms $3.60 AUD per share).

This was perhaps one of the bigger surprises of the year so far given WBC’s penchant to be the perennial laggard. Not only were 1Q21 revenues 100bps higher than the previous quarterly, it has been a story of turnaround in every single notable metric. This includes expenses down by 2%, CET1 up by 74bps from the previous quarter (though substantially lower than CBA) and bad debts benefit of $501m. Numbers-wise, statutory net profit was $1.7bn and cash earnings were $1.97bn, up 54%.

While the bank remains substantially less well capitalised when compared to CBA, what has been quite interesting for me was the fact that NIMs stood at 2.06%, not only is this higher than CBA but it is an increase of 3bps from the previous half. It showcased a clear turnaround story in the making for me.

Red Flags & Risks: Much of the recovery is predicated on continued housing growth and continued momentum in the cost cutting measures. The bank is also unique in its concentration of exposure to the NSW housing market compared to the loan books of their competitors.

My Expectations: This is one firm that I have done a complete 180 on in terms of my expectations. Not only did the NIMs improve, as opposed to my forecast last year of 1.6-1.75%, but management has continued to deliver on its cost cutting measures and de-risking its balance sheet. The bad and doubtful debts (BDD) has also continued to see substantial improvements. All round, this is a management story and Peter King has proven me wrong. Apparently appointing insiders in times of upheaval isn’t all that bad after all.

Dividend Yield: Expected yield of 7% (assuming a share price of $24 AUD and a payout ratio in line with 2019).
I remain of the conviction that management are likely to be incentivised to play catch up this year. This remains a better bet then CBA in my view from a dividend perspective.

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Next week, NAB and ANZ!